By Michael Gilbert
John Maynard Keynes, the famous economist who argued for fiscal stimulus during the Great Depression, said “in the long-run we’re all dead.” Perhaps an appropriate equivalent is, if we fail to act, “in the short-run we’re all dead too.” No matter how we choose to handle COVID-19, there are economic ramifications, some of which are already being felt throughout the community.
Economic health problems require economic prescriptions, and there are two types we can choose: monetary policy or fiscal policy. Monetary policy is conducted by the Federal Reserve Bank (specifically the Board of Governors; we have one of 12 banks here in Richmond), while fiscal policy is conducted by governments.
The Great Recession saw heavy use of monetary policy by the FRB, such as quantitative easing (buying bonds or mortgage backed securities from banks in exchange for cash, injecting cash and increasing the availability of money), as well as fiscal policy in the form of stimulus, such as the $250 check you may have received in 2009.
While the FRB has responded to COVID-19 seriously (lowering the target federal funds rate, changing the reserve requirement, restarting quantitative easing), the market’s reaction has been generally negative. This is directly because of the lack of federal government response, and commitment from fiscal policy. The market rallied when Trump finally addressed the nation’s response, and we heard some fiscal policy proposals.
The more we can concretely address how to mitigate COVID-19’s effects on the factors of production (land, labor, capital, entrepreneurship) the less pain our economy will feel.
What made the Great Depression so terrible was the FRB not acting appropriately by making money more liquid and readily available, instead raising the discount rate. As a former professor and mentor of mine once said, “money is to the economy as fuel is to the automobile.”
Without money flowing, our economy grinds to a halt.
This matters because the dirty secret is that consumption makes the world go round, responsible for about 70 percent of our GDP (if we’re all diligent savers, the economy will grind to a halt). The role of FRB in many ways, is to tell everyone that it will be okay, to assuage and allay fears. As the philosopher George Berkeley posited, “esse est percipi”, or perception is reality – if you think the economy will be worse off tomorrow, you don’t buy today, and then the economy really is worse off tomorrow.
What makes this so different?
During the Great Recession, the key problem stemmed from improperly classifying risk related to mortgage-backed securities and the associated credit default swap.
The source of contagion here is not a financial one, so markets (and the American public) are not primarily concerned with a monetary response. Now we look to the federal government to assuage and allay fears. In theory, a stock price contains all current and future estimated profits of a company, so the longer the uncertainty with the response to how those profits could be affected, the more negative they appear to be.
Markets and citizens deserve a well-thought and well-intentioned plan that is effectively communicated to properly estimate forthcoming economic hardships. (Congress was at work over the weekend hammering out another aid package.)
What happens next? Many of the COVID-19 effects can already be felt in our community. Small businesses, particularly in the service and hospitality industries will be negatively disproportionately affected and will shutter. These businesses rely heavily on cash-flow to be successful. The effect is compounded in college towns, where these businesses already struggle during summer, and now that period has effectively doubled. Not everyone can work from home. The entertainment and transportation industries will also be negatively affected.
So, a coffee shop closes its doors. Now those employees are unemployed, but the coffee shop’s suppliers are also affected (with swaths of perishable inventory). And both the coffee shop and its suppliers rely on transportation for orders, which is also affected. Don’t forget importers or brokers. Remember that many of these businesses are on terms, so the wholesalers are already taking a loss on what’s been delivered, plus what isn’t being ordered. Now the banks begin to be affected.
At the city-level, we can expect declines in revenues from the 1% local option sales tax, meals tax, lodging tax, admissions tax, and vehicle rental tax, among others. The city may need to tap the rainy day fund, but at a minimum must have a plan for these expected declines in revenue.
The FRB announced Tuesday that it was ready to fulfill its role as lender of last resort, establishing both a commercial paper and primary dealer facility, and a joint statement with the FDIC and OCC encouraging banks to use resources to support households and businesses. This is a great move, but monetary policy alone is not enough.
As we learned with the Great Depression and Great Recession, we have got to keep the money flowing. There have been talks of a $1,000 paycheck, a form of fiscal policy stimulus, but that alone is not enough.
Think of all of the people affected by the coffee shop’s closure, but reproduce that over and over to other small businesses and their employees throughout Virginia and the U.S. There are approximately 205 million people who make up the “working age population” in the US, and we should consider [the option to exercise] multiple monthly checks at twice or more than what is being proposed. At $2,000 a check, over three months, that comes to $1.2 trillion. A more targeted approach is doing this by industry, or perhaps using adjusted gross income as a threshold; having different amounts per dependent. A $1,000 check may be enough to cover rent and some food. But what we need is to create discretionary income, so that income can quickly make its way back into the local economy. Some time should be spent thinking how that excess can make its way to local small businesses during the outbreak, helping those hit hardest.
We should also consider other impacts from these businesses. While purchasing gift cards is helpful, it’s probably not enough, so the business remains shuttered. Should a business “lay off” its employees so they can file an unemployment insurance claim? Initial claims are already surging, nationally and in Virginia.
Will the commonwealth freeze unemployment insurance premium increases during this period, or will they skyrocket to the point that it’s not rational for the business to open again? What must be done, and how quickly can funds be disbursed through the Small Business Administration’s disaster loan program? If Gov. Ralph Northam orders no more than 10 persons in restaurants, who compensates the restaurant’s quashed revenue? Is a low interest loan even viable – why keep payroll open if you can only have 10 people in sales at a time?
The trade of livelihood for health is easier when it’s our life on the line but not our livelihood.
Though the government cannot (and should not) coerce private businesses, banks can also step up to the plate here after receiving their share of assistance during the Great Recession. Wells Fargo, having fraud after fraud in the news, might gain some currency by simply acting as if the next three months never existed (that is, everything just moves out by N-months, so payments remain the same and the period missed is not calculated back in). For securitized mortgages in tranches, we might see similar action by the FRB as the Great Recession. This is likely the first serious test of Dodd-Frank and Basel III, products of the Great Recession designed to strengthen banks in times of crisis and contagion.
If banks are too big to fail, why aren’t the American people, who make up the banks and so much more?
The breadth and depth of this economic hardship is affected by how hard we dampen the curve. The tradeoff is the flatter the curve, the wider, so the longer some of these hardships will be felt. We certainly shouldn’t risk overburdening our health care system and the unnecessary loss of life, but if we feel a longer economic pain, the government must step up in easing that pain.
Falling oil prices will likely be helpful in recovery: as travel prices remain “sticky” from the oil and demand shock, consumers feeling safe again will see good value in travel, change their taste and preferences, and shift the demand curve.
Some of the best advice I’ve seen is: rather than fret if you have the virus or not, assume you have it, and behave in ways to prevent its spread to others. We will get through this. The ease at which we navigate these choppy waters wholly depends on the federal government’s response and seriousness in approach.
This is not a game show, but the world is watching, and America will either fire or hire a president come November.
Michael Gilbert was previously an economist for the City of Richmond and the state government and is passionate about local government, economics and data science. An adjunct economics instructor at Virginia Commonwealth University, he has a B.S. in economics and a B.A. in philosophy from VCU, and a M.S. in predictive analytics from Northwestern. Views are his own.